INTM255160 - Controlled Foreign Companies: exemptions - the motive test: Introduction to the motive test

The fifth and final exemption in ICTA88/S747(1) is the motive test which applies ‘notwithstanding that none of paragraphs (a) to (e) of subsection (1) above [i.e. the other four exemptions] applies’.

The motive test was introduced because it proved impractical to devise comprehensive objective tests that ensured that all United Kingdom controlled overseas subsidiaries with profits derived from genuine overseas activities were excluded from the controlled foreign companies’ charge. It’s presence in the legislation, however, emphasises the fact that the United Kingdom’s controlled foreign companies’ rules are aimed squarely at countering tax avoidance.

The objective tests provide groups with the certainty that the vast majority of overseas subsidiaries will be exempt from the controlled foreign companies’ rules. The motive test then sweeps up those that, whilst not set up to avoid UK tax (and therefore not within the intended scope of the controlled foreign companies’ rules), nonetheless do not fit within the specific criteria of the objective tests. The intended result is that only overseas subsidiaries that exist, or carry out transactions, with the aim of avoiding UK tax will be subject to a charge under the controlled foreign companies’ rules.

Such an approach is, of course, not without difficulties - principally because of two main issues:

  • despite numerous valiant attempts there has never been a consensus about what is meant by ‘tax avoidance’ and the term is itself somewhat emotive; one man’s ‘tax avoidance’ is another man’s ‘tax efficiency’; and
  • whilst the purpose/reason behind any transaction is basically simply a question of fact, virtually every transaction has a number of different purposes and interpretation of them is inevitably subjective.

The motive test attempts to solve the first problem by:

  • avoiding any mention of the term ‘tax avoidance’, settling instead for the rather more neutral concept of a ‘reduction in tax’; and
  • providing a statutory definition of what is meant by ‘a reduction in tax’.

The second problem is addressed by means of tests of the main purposes for a controlled foreign company’s transactions and the main reasons for its existence - with each case to be decided on its own facts and circumstances.

This section explains what the motive test is and how it applies in practice. A series of brief examples at the end of the section, from INTM255430 onwards, illustrates its application in certain generic situations.

A UK company can apply for a clearance in respect of the application of the motive test relating to its own specific circumstances which will help provide certainty for that company going forward. A clearance application may be made in respect of a single Controlled Foreign Company or a sub-group of the UK company. See INTM256720 for further information.